Anthony Hilton: Forget Cyprus - the eurozone is still deep in crisis

Russian tax dodgers may have crippled the Cypriot economy but the real concern is the euro’s future

Monday 25 March 2013 11:56 BST

Last night’s last-minute bailout for Cyprus has staved off a minor meltdown and saved its smaller depositors. The much larger question is whether this saga has left the eurozone weaker and what it means in terms of the long-term battle to save the euro.

It is tempting to think of Cyprus as like Shetland with better weather — a place so small in financial terms that what happens to its economy is really of no concern to anyone but those who live there.

And that would have been the case but for two things. First, some 20 years ago Cyprus set out its stall as a tax haven where people don’t ask too many questions. One of its first and biggest customers was Slobodan Milosevic, who found he could evade Europe-wide sanctions against his regime by funnelling his money through Cyprus. Where he led, Russians followed. Not only is the island the base for some of the key companies in the groups run by that country’s oligarchs but it has become the haven of choice for the averagely wealthy too.

This brings us to the second reason. Cyprus is geographically and culturally convenient for Russians — and is also within the EU, and since 2007, the eurozone. In Russian eyes, this gave it a security other locations lacked.

But being an offshore banking centre comes with risks. As billions of roubles poured into Cyprus its banks ballooned, and soon the deposits of Russian money were worth several times more than the entire country. As with Iceland and Ireland, there was too much for the domestic economy to absorb. As much as possible went on overpriced property but the bulk of the rest was lent to Greece. The losses when that country hit the skids are what tipped the Cyprus banks over the edge — though in fairness the way things were going it would have happened sometime anyway.

Should we care? I tend to think not — but others take a different view. The world left Iceland to sink when its banks imploded a few years ago, and while it was horrific for them it was containable for the rest of the world. On that basis Cyprus or its banks could go bust with much distress for those who live there — including a fair number of British ex-pats and Russians — but with few side-effects for the rest of the world.

But others say this cannot happen because Cyprus is part of the eurozone chain and a chain is only as strong as its weakest link. So Cyprus has to be saved to preserve the integrity of the euro. The trouble is that the Germans, whose money tends to get used on these occasions, are unconvinced that Cyprus should be saved. They think its tax-haven antics make it a special case and question — with considerable justification — why German taxpayers should bale out Russian tax dodgers.

Others negotiating alongside the Germans took a different view. They believe the huge damage done by allowing Lehman to collapse into bankruptcy four years ago shows that a banking crisis is a bad time to start making moral judgments. They believe the point of the rescue is to maintain confidence in the integrity of the eurozone as a whole. So their preferred solution was to hold their nose and come up with the money.

The other controversial ingredient was the insistence that the Cypriots find a large chunk of the money themselves: this led to the Cypriot government hatching the plan to confiscate a slice of people’s bank deposits. The decision that all should share this pain seems to have been insisted upon by the Cypriot Prime Minister; in his previous life as a lawyer he had a lot of Russian clients, so perhaps he knew how angry they could get.

That deal fell apart; now we have a new one. It is always a mistake to take these things for granted until they are set in stone. But it has certainly underlined two things. First, in spite of all the talk of recent months, the eurozone is still a long way off achieving the level of banking union the single currency needs. The supervisory side of such a union is being developed relatively fast, but the bailout side, where all banks’ debts become the responsibility of the eurozone as a whole, has obviously not got the support it needs to work.

Second, the raid on small savers, though it was abandoned, might have let the cat out of the bag. One of Europe’s core principles is that small savers have their bank deposits protected and the fact that the rescuers even considered breaking that rule could be seen as a serious error — and one which, though abandoned, will not be forgotten. It could have a long-term damaging effect on people’s confidence in their banking systems.

On the other hand, the real surprise of the past couple of weeks was not the performance of the politicians on stage but rather the behaviour of the audience. In past times markets would have panicked at what was unfolding; this time they barely reacted at all.

This could mean they have become so shell-shocked that they no longer realise when they are in mortal danger. Alternatively — and more probably — it suggests agreement with the German view that Cyprus is a special case that could be left to sink without it being the end of the world.

What we have learned is that it is the fate of the big actors in the eurozone drama — the likes of Italy, Spain and France — which will ultimately determine the future of the single currency, not what happens to the bit part players. It is Hamlet who matters, not Rosencrantz and Guildenstern. So for the moment the play goes on — though given what happens to Hamlet, that may not be much of a long-term comfort.